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Abstract

CSD is a prophetic book, which contains two forecasts. The first of these was that capitalism would destroy itself due to internal decay, and the second was that it would be replaced by socialism. Schumpeter was right about the decay of capitalism but wrong about socialism replacing it. I suggest that this partial failure can be explained by his lack of interest in institutions. The definitive illustration of this is his contention that ‘it is entirely immaterial whether or not changes [in the institutional framework] are embodied in, or recognised by legislation’ (1939: 11).

What Schumpeter understood by capitalism was described in his massive 1939 book, Business Cycles. This is history of technology superimposed on cyclical economic theory as developed by the Russian economist Kondratieff. In his 1911 book Schumpeter had noted that ‘innovations do not emerge regularly but are more in evidence at certain times than at others.’

(223 ff.) Reflecting this, his account of three long cycles shows each to begin with a ‘cluster’ of innovations. These cycles were the Industrial Revolution, the Age of Steam and Steel, and Electricity, Chemicals and Motors. Significantly the last cycle ended in 1929, the year of the great crash.

Business Cycles was criticised (e.g., by Kuznets in AER) for its reliance on these clusters as the originators of economic upturns, because Schumpeter offered no reason why they should exist at all, much less be the cause of long cycles of economic development. In fact, they can be shown to be the results of institutional change, in the form of property rights. The first cycle is perfectly explained by the coming of real property, that is, ownership not subject to arbitrary interference from rulers; (Landes the second by the crucial change in the law which delivered limited liability to investors in joint stock companies; and the third through intellectual property, especially in the form of patents and trademarks.

Mandel (1975) studied long economic cycles from a Marxist perspective, and found it ‘astonishing’ that Schumpeter should have overlooked the importance of any institutional change that brings with it the prospect of a steep rise in the rate of profit. Limited Liability for investors in companies increased their rate of profit so much that it that it may even be the reason why the revolution called for in the Communist Manifesto in 1848 never happened in capitalist countries. It led to so much investment, profit and employment in the second half of the 19th century that the claim to workers of ‘having nothing to lose but their chains’ came to fall upon deaf ears. Schumpeter’s concept of creative destruction, whereby it was innovation or the lack of it which decided which firms should live or die, was a crucial component of this dynamic process.

I suggest that Schumpeter was so anaesthetic to institutions and institutional change, because there are two basic approaches towards understanding economic life. One is the long western tradition of seeing it as depending upon cultural values expressed in laws and institutions, especially insofar as these relate to ownership. Economics studies exchanges, but peaceful exchange is only possible if there are respected property rights; otherwise only might is right. This approach is summed up by Keynes at the end of the General Theory as ‘soon or late, it is ideas, not vested interests that are dangerous for good or evil.’

Marx and Engels thought the opposite, that ideas, laws and institutions are reflections on a psychic plane of economic realities. It is necessary to bring Engels’s name into any reference to Marxism, because although they both shared the writing of the Communist Manifesto, so much of what is expressed in this reflects Engels’s experience in Manchester which led to his polemic on The Condition of the Working Class In England.

Schumpeter is not considered, nor would he have considered himself as a Marxist, but he certainly shared the view of Marx and Engels that economic life is powered from the bottom up rather than from the top down. In his case, this may well owe much to his early ambition to develop economics as ‘a scientific discipline distinct in kind from political economy… logical and mathematical’ (McCraw 2007:49) If this could be achieved, it would of course have to be free from influence from any exogenous source.

As he did indeed forecast, the capitalism that Schumpeter wrote about did not survive, but it was not replaced by socialism as he thought it would be.

Instead, the institutions in which he had no interest, but which are the main sources of all economic change, were captured by interests. The dynamism of his capitalism as he so well identified it, was creative destruction, in which the more innovative firms survived in competition with less innovative ones. Limited liability enabled firms to grow without limit to the extent that they cannot be challenged any more in this way. Similarly, patent law was changed worldwide so that is it only could be used to strengthen the largest firms. Creative destruction could not survive this ubiquitous growth in market power.

It was also institutional change that led to the dominance of money in the economic process (Kingston, 2020). Early versions of limited liability law explicitly denied its application to money, for example banks in the UK only obtained this privilege in 1879, just a century since the first law of this kind in the world was passed. Although this completely shifted the balance between economic production and the measurement of it, in favour of those who controlled the measuring, Schumpeter was blind to the importance of the legislation. According to Arena and Dangel-Hagnauer (2002) he held that ‘money is as little a creature of the law than is any other social institution.’ Consequently, it was his student, Hyman Minsky (1982) who applied the cyclical theory to which Schumpeter had devoted so much attention, to booms and slumps in finance.

This capture of laws, especially as they relate to property, by interests has undermined the state itself in the context of a remarkable insight in one of Schumpeter’s least-known books, The Crisis of The Tax State. This is his comment on the State ‘that it is part of its nature that it opposes individual egoism as the representative of a common purpose. Only then is it a separate indistinguishable Entity.’(1918:110) Since it was institutional changes that allowed individual egoism to run free, it is unfortunate that Schumpeter’s preoccupation with socialism as capitalism’s replacement, prevented him from developing this insight.

Any tendency to replace the old capitalism by socialism, as in Roosevelt’s New Deal, was inhibited by the influence of interests on the media, and even on the democratic process itself. And Schumpeter was short of reasons why it should be socialism rather than anything else, that would replace capitalism. On page 169 of CSD he does ask the question ‘Can socialism work?’ and then goes on to reply to this, ‘Of course it can!’ A few pages later (172) he asserts that ‘there is nothing wrong with the pure logic of socialism.’ It is surprising that he did not advert to the fact that whatever form this ‘pure logic’ takes in practice, it cannot fail to increase the power of bureaucracy greatly.

The bureaucracies that Schumpeter had known in Europe were all clones of Napoleon’s reform in France followed by Hardenberg’s in Prussia. They were efficient because they were staffed by people with enough private means to have a significant degree of independence of their political masters. The social class from which they were drawn was a casualty of World War 1, and those who replaced them were dependent upon their salaries. Schumpeter had nothing but contempt for the United States civil service of the New Deal era: ‘ there was no experience, no esprit de corps, no clear idea of what a civil service is and what it can and cannot do.’ (CSD 293).

References

Arena R and Dangel-Hagnauer C 2002 The Contribution of Schumpeter to Economics: Economic Development and Institutional Change. London Routledge.

Kingston, W 2020 How Capitalism Destroyed Itself: Technology Replaced by Financial Innovation. Oxford Peter Lang.

Kuznets S 1940 Review of Business Cycles. American Economic Review pp. 257-271.

Landes D 1989 The Unbound Prometheus. Cambridge Cambridge University Press.

Mandel, E Late Capitalism. London New Left Books.

McCraw, T K 2007 Prophet of Innovation: Joseph Schumpeter and Creative Destruction. Cambridge MA Harvard University Press.

Minsky, H P 1982 Can It Happen Again? Essays In Instability and Finance. Armonk, NJ, M. E. Sharpe.

Schumpeter, JA 1934 [1911] the theory of economic development translation by R Opie. Cambridge MA Harvard University Press.

Schumpeter, J A 1997 [1942] Capitalism Socialism and Democracy. London Allen and Unwin.

Schumpeter, J A 1991 [1918] The Crisis of the Tax State. English translation in Swedberg, R.(ed.) The Economics and Sociology of Capitalism pp. 1 – 140. Princeton University Press.

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